The European Central Bank’s (ECB) decision to cut interest rates in June raised hopes that more was to come – not in this week’s meeting but later in the year. However, in recent weeks some more caution has come into the outlook, due to a range of economic and political factors. After Thursday meeting ECB president Christine Lagarde pointedly refused to indicate another cut in September, saying what happens then remains “wide open“. So what can borrowers expect and is there a risk that the promised further reductions will not arrive, or at least not for longer than anticipated?
The backdrop
The ECB’s drive to bring down inflation from the unprecedented heights reached during the cost-of-living crisis took interest rates to record levels. The medicine has appeared to be working, at least in tandem with international trends, with energy prices falling back sharply from levels reached following Russia’s invasion of Ukraine. The euro zone inflation rate, having peaked at 10.6 per cent in October 2022, fell to 2.5 per cent in June and the ECB believes it will gradually fall to the target 2 per cent level by the end of next year. On its forecasts, euro zone inflation will average 2.5 per cent this year and 2.2 per cent next year. So all fine then? Perhaps, though there are still some uncertainties.
The last mile
The inflation rate has fallen a long way – and over a short time period. But the more cautious wing of the ECB – and the US Central Bank, the Fed – worry about “the last mile” – getting the inflation rate from where it is now right down to 2 per cent – and the International Monetary Fund has cautioned that this road could be “bumpy”. This reflects a concern that embedded inflationary pressures, showing up in the jobs market or the services sector, for example, may be hard to control, and could risk keeping inflation above target.
“Some of the data that have become available aren’t quite as favourable as the ECB has been hoping for,” according to economist Simon Barry, “with this week’s consumer price figures for June confirming that core price inflation – excluding food and energy – is running higher than anticipated heading into the second half of the year, with services price inflation continuing to prove particularly sticky at over 4 per cent.”
The key decisions now facing Donald Trump which will have a big impact on the Irish economy
Election campaign got off to spluttering start on economic and budget issues. Here is what it all means
Donald Trump’s economic plan: the key areas for Ireland
Cliff Taylor: How the return of SSIA-style incentives might be on the cards for Irish households
This means, he said, that it is going to take more time for the ECB to have enough data to assess whether its expectation for inflation to return to target by around the end of next year (and stay there) remains on track.
There are also concerns about the impact of the turbulent world of geopolitics in 2024. Senior ECB sources have reportedly identified the recent election in France as a concern, with fears that a left-wing government might do little to bring down the budget deficit, or that populist expansionary measures which could fuel inflation might be included in a new government’s programme. Other risks lurk in the background – such as tariffs and a trade war sparked by a Trump presidency.
There are always political risks, of course – and it is important to note that these factors could affect growth as well as inflation and so the implications for interest rates are not straightforward.
The outlook
The uncertainties mean that the outlook is a bit more unpredictable and risky. Nonetheless, as of now, another ECB cut – probably of a quarter point – is anticipated in September, at the first council meeting following the summer break. A recent survey by German institute ZEW – of 350 mainly German-based analysts – said that most anticipate that interest rates will now be on a gradual downward path but with “a high degree of uncertainty” about how quickly or how far borrowing costs would fall.
Given this level of doubt, market analysts expect that the ECB may be guided by a combination of official data, much of it available quarterly, and updated estimates from its own staff, which are provided every three months. So, according to Barry “it’s not a coincidence that market interest rate expectations very much align with this timetable, with markets priced for two more moves this year, in September and December”, which are the dates new ECB staff projections will be provided. According to the ZEW survey, 68 per cent of economists expect a cut in September and 73 per cent anticipate one in December, but just 24 per cent expect a cut in the meeting in-between in October.
If this is correct, and the cuts are of a quarter point each, then the ECB deposit rate would be 3.25 per cent by the end of this year and further reductions could be in prospect in 2025, taking the deposit rate down to 3 per cent or slightly below.
Inevitably, this kind of forecasting is an imperfect science and we have seen before how market expectations can change very quickly. All borrowers can do is act on the basis of current information and reasonable expectations.
What does this mean for borrowers?
The recent mood music on interest rates has been a bit more cautious and the risks of a slower than expected pace of decline have been underlined. Also, it is clear that the ECB council remains split on the appropriate pace of reductions and data will thus be vital in swinging decisions one way or the other.
For now, however, the expectation remains that there will be two more reductions – probably of a quarter point each – over the balance of this year and some further cuts in 2025. As Simon Barry points out, the current level of interest rates remains high and so even if there are further reductions, the ECB can be confident that they will still act to hold down inflation. There is plenty of room for debate on the “neutral” level of interest rates – the one which neither stimulates nor depresses economic growth and inflation. But on any calculation it probably translates to a deposit rate in the 2 to 2.5 per cent range. That means there is still plenty of room to cut.
Any ECB reduction knocks on immediately to tracker mortgage holders. It is first important to note that most will receive a quarter point “bonus” cut in the autumn, because of a technical change in ECB interest rates – the central bank has announced that it intends to close the gap between its deposit rate (now 3.75 per cent) and the so-called refinancing rate, now 4.25 per cent. The gap between the two rates is to be cut by 0.35 of a percentage point and as tracker mortgages are generally priced off the refinancing rate, there will be a small fall in repayments.
If the current market forecasts are correct and the deposit rate, having fallen once already, is cut twice more in 2024, then – adding in the bonus – tracker rates should fall by just over one percentage point in 2024. As they rose by 4.5 points this is only giving back some of the losses – some further decline can be expected next year, but tracker rates will not be returning to previous rock bottom levels.
First-time buyers, movers or those whose current fixed term is running out have traditionally opted for fixed rate products in recent years, though more have gone variable this year in the hope that offers would improve. Many have been rewarded as an outbreak of competition which started around March and the first ECB cut led to a series of reductions.
But there is still a huge spread of interest rates and with the prospect of market interest rates falling, albeit slowly, some still look on the expensive side, meaning care is needed. For example, the “green” rates – or those available to higher BER rated houses – look attractive, with many in the 3.5 per cent to 3.75 per cent region. However for non-green loans rates can, in some cases, go from 4.5 per cent upwards to over 5 per cent. This looks high at a time when, for example, a smaller lender, Avant, is offering fixed rates generally below 4 per cent.
There are a lot of variables now in loan applications and the associated cost. So the message is to shop around and take professional advice from an independent broker, which will usually not cost anything. And to realise that after the first outbreak of competition, the gentle downward pace of ECB rate declines – and the uncertainty about these – are likely to mean slow enough downward progress in fixed rate offers – and in standard variable rates – from here.
Competition may, we would hope, lead to cuts in some of the more expensive interest rates, but the offers around 3.5 to 4 per cent may not fall much further for now. If the ECB cuts again in September and there are expectations of another move in December, pressure may come on again for another general round of reductions. Rates went up quickly, but reductions will come slowly.
